A minimum price sets the lowest level that a good or service can be legally sold for. The desired effect is that consumption of the good will fall, resulting in a welfare gain to society.
Setting a minimum price for alcohol (or other demerit goods) has become an increasingly common strategy for trying to tackle over-consumption.
Graphically, the effect is that demand contracts, to ‘b’ and supply extends, to ‘c’. This would create a surplus of the good.
However, this only happens if the minimum is set above the market rate. If set below, the market rate prevails.
If we consider the following data on market demand and supply for an alcoholic drink, we can see that the free market equilibrium is at a price of 4 euros. If, however, a government sets a minimum price of 6 euros, then demand will contract from 800 units to 400. However, supply will extend to 1200, creating a surplus of 800 units.
The impact of a minimum price depends on the price elasticity of demand and supply.
When consumers are unresponsive (inelastic) in terms of their response to a minimum price, the reduction in consumption will be relatively small. Similarly, when supply is inelastic, producers cannot increase production quickly, with the result that the surplus is small.